A simple Chapter 13 case can be filed to do ONE special thing better than a Chapter 7 one could do, or to do MULTIPLE things better.
Chapter 13 is the Bankruptcy of Special Powers
Consumers file a Chapter 13 case mostly because of significant advantages that it gives them over Chapter 7. Also, sometimes but not often, they file under Chapter 13 because of not qualifying under Chapter 7.
In 2012, although less than half as many Chapter 13s were filed as Chapter 7s, that still a lot of people. According to the Administrative Office of the United States Courts, 366,532 Chapter 13s were filed last year. Since about 35% of consumer bankruptcies are jointly filed by a married couple (according to this report by the Institute for Financial Literacy), that means about a half-million Americans filed Chapter 13 in 2012.
Why are all these people choosing a procedure that takes about 12 times as long to finish—usually three to five years instead of the three or four months to do a simple Chapter 7 “straight bankruptcy” case?
“Adjustment of Debts Bankruptcy” in a Nutshell
They are filing under Chapter 13 because it allows them to do what Chapter 7 does not. In a simple Chapter 13 case, you could:
1) catch up on your mortgage arrearage, have up to 5 years to do so, while continuously being protected from foreclosure;
2) possibly “strip” off a second or third mortgage from your home’s title;
3) possibly do a “cramdown” on your vehicle loan(s), reducing both your monthly payments and the total amount paid for your vehicle(s);
4) pay that portion of back income taxes that can’t be discharged, while being protected from tax collection by the IRS and state tax agencies;
5) cure child and/or spousal support arrearages while being protected from the extreme collection powers of support enforcement agencies; and
6) keep assets that you would lose under Chapter 7.
We cover the first two of these in today’s blog, and the rest of them in the next one.
Cure Mortgage Arrearage
Probably the biggest reason people file Chapter 13 is to save their home, and the most direct way it helps is to give them the length of their case—up to five years—to catch up on the payments they’d fallen behind on with their mortgage lender.
In a Chapter 7 case, your lender could start or resume a foreclosure right after your Chapter 7 case is over (often sooner if it is aggressive about it). You’d pretty much be at its mercy about how much time you’d have to cure the arrearage. 1 year is often the maximum amount of time. If you have fallen behind by $10-20,000 or more—not unusual—coming up with an EXTRA $1,000-2,000 per month beyond your regular monthly mortgage payment is beyond most people’s ability.
In a Chapter 13 case, your catch-up payments are much lower because you have so much longer to catch up. And your lender can’t start or resume a foreclosure as long as you maintain the payments that your court-approved plan specifies.
“Stripping” a Second/Third Mortgage
If your first mortgage balance is less than your home’s value, Chapter 13 gives you the power to “strip” your second mortgage off the title. That means that the second mortgage is treated as a debt no longer secured by your home (since there is no equity backing it), which in turn means that you would no longer need to make the monthly payments. And that debt would only be paid to the extent, if any, that you would have extra money during your Chapter 13 case to pay it.
This applies to third mortgages as well, as long as the combination of the first and second mortgage balances exceeds the value of the home.
When calculating in the future interest payments that you would no longer have to pay, a mortgage “strip” could potentially save you a few hundred thousand dollars. And it can take a home that is hopelessly “under water,” and bring its debt closer to its value, making holding onto the home much more economically sensible.
Even just looking at these first two special powers of Chapter 13, either one of these alone can be plenty reason to file under this Chapter.
If you were $15,000 behind on your mortgage, but could only afford to pay $300 extra each month towards this arrearage, even after not paying your other creditors, that would take you 50 months of bring you current. Very likely that would not be nearly fast enough to stop your mortgage lender from continuing or starting a foreclosure after you would finish a Chapter 7 case. But it would very likely be a perfectly appropriate amount under Chapter 13.
If you owed $275,000 on your first mortgage, on a home that had slid in value to $260,000, and also owed $110,000 on a second mortgage with monthly payments of $1,000, “stripping” that 2nd mortgage in a Chapter 13 case would enable you to stop paying the $1,000 per month, and over the life of that loan could potentially save you $200,000 or $300,000 in principal and interest (depending on how long you kept the home).
Neither of these two powers is available under Chapter 7. Clearly, either of these alone would make Chapter 13 worthwhile, and it’s especially powerful when used in combination.